I’m undertaking a 1000-day reinvention project, blogging here daily to track my progress. In Tuesday Book Club, I share an idea from a book.
All traders are not speculative traders: There exists a segment called market makers whose job is to derive, like bookmakers, or even like store owners, an income against a transaction. If they speculate, their dependence on the risks of such speculation remains too small compared to their overall volume. They buy at a price and sell to the public at a more favorable one, performing large numbers of transactions. Such income provides them some insulation from randomness.
Nassim Nicholas Taleb, Fooled by Randomness: The Hidden Role of Chance in Everyday Life
Market makers in equity options are financial performs that provide liquidity by continuously quoting bid and ask prices for the stock options that I have recently devoted myself to trading. This allows investors such as myself to enter and exit positions without waiting for someone — a counterparty — to take the other side of the contract. So if I want to sell, for example, a put contract on $MU with a 6/18/2026 expiration and a 700 strike, I can do that pretty much immediately at the mid price between buy and ask because of the presence of market makers.
A put or call seller also serves a purpose in the markets: providing insurance to those who want to hedge or speculate on stock movements. When I sell a put, I’m providing a backstop against a potential decline in the underlying stock’s price. It’s a form of insurance, and I get paid a premium for that. But then I must pay out by buying the stock if the underlying’s price goes down to the strike price or below. That’s when the insured makes a claim to me, the insurer.
But not content to take on the risk without hedging my own risk, I’m now starting to trade spreads instead of simply selling puts. When I sell a put and then buy a put with a lower strike price, I’ve essentially bought a sort of reinsurance for my main position (the short put). The presence of the long put with a strike price below the short put means that if the underlying price falls below my short put strike price, I am protected at some level by being able to demand that someone buy the shares I may be forced to buy, though at a lower price than where I bought them.
I can effectively act as an insurance provider with bull put spreads and bear call spreads, collecting premiums while protecting my downside risk. Over time, if I am careful to select a diversified set of underlying stocks to sell insurance on and pay careful attention to market regimes as well as individual stock trends, my earnings should outweigh my losses.
It requires, however, that I routinely take on the risks of wins and losses. With this approach I won’t make any big wins but I also shouldn’t have any humongous losses.